Q: I know that I’m supposed to keep some of my investment portfolio in stocks, and some in bonds. How do I choose what bonds to buy?
A well-allocated investment portfolio should contain a stock component and a bond component. As a general rule, I often suggest that investors subtract their age from 110 to determine their appropriate stock allocation, and the rest of their portfolio should be in bonds. For example, I’m 35, so this implies that I should have 75% of my money in stocks and 25% in bonds.
However, buying individual bonds isn’t the best way to go for most people. For one, the bond market is complex and can be difficult to navigate. Additionally, when you want to eventually sell them, many bonds aren’t very liquid — meaning you can’t simply hit a button and sell them immediately. Furthermore, all bonds (except Treasuries) have some level of default risk.
For most investors (myself included), bond mutual funds or exchange-traded funds (ETFs) make more sense. The Vanguard Total Bond Market Index Fund ETF (NYSEMKT:BND) is one smart choice. It sports a low 0.05% expense ratio and spreads your money out across thousands of bond investments. Another solid choice, especially if you’re worried about inflation, is the iShares TIPS Bond ETF (NYSEMKT:TIP), which invests in government-issued, inflation-protected bonds.
Of course, there are many other good options. You can invest in a Treasury bond fund if you want safety, a long-term bond fund if you want more income, or a tax-exempt bond fund if you’re in a high tax bracket, just to name a few scenarios. But individual bonds should generally be left to professionals and those with the knowledge and desire to invest in them. For the rest of us, bond funds are usually the way to go.
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